Central Fund issues shares to buy $50 million in bullion


By Thom Calandra
June 7, 2002

As gold's polar opposite, Nasdaq, gets blasted, bullion
investors expect miners' risky hedge books to further boost
the metal.

By some estimates, gold mining companies are hedging, or
selling forward, about 4,000 tons of gold. Some analysts say
it's far more. As gold prices continue to rise in the face of a
weak stock market and a declining dollar, most of the world's
largest hedgers are looking for ways to reduce the hedge risk
from their books.

Earlier this week South Africa's AngloGold Ltd., the second
largest gold miner as measured by production, indicated it
would continue to slim its hedge book. The company took
105 tons of gold off its forward-sale program in the six months
ended March 31.

Other highly hedged companies, including Canada's Barrick
Gold, say they will keep slimming their use of derivatives and
the bullion leasing market to hedge gold production. In bad
times, when gold prices were below $300, such practices
created extra revenue for gold companies. Hedged
instruments harvested a higher gold price than was available
in the spot market for bullion.

Yet critics of the practice long have pointed out how hedging
by gold miners battered the gold price, mostly by encouraging
the lending of central banks' gold reserves to investment
banks, which then design hedge programs. Essentially,
hedging of any type is a short-sale against the price of gold.
Now that gold is flirting with $330 an ounce in the spot market,
gold's most outspoken investors see the hedge-rush adding
speed to the gold rush.

"I see $340 and $360 an ounce as the danger zone for banks.
That is where hedging and the hedge book problems start to
have an impact," said Ian McAvity, editor of Toronto newsletter
Deliberations on World Markets and a director of gold and
silver closed-end fund Central Fund of Canada. "I expect to
see a $25 up day for gold one day, largely due to someone
getting skewered by their hedge book, either the bank that
extended it or the mining company."

A rapidly rising gold price is the worst enemy of hedged
miners and the banks that designed their derivative strategies.
A powerful gold rally could force some miners, or the banks
behind the hedge books, to engage in a mad scramble to
locate gold and deliver it to the original lenders.

McAvity points to the largest investment banks, among them
JP Morgan Chase, as facing the most risk from the continuing
gold rally. Gold's spot price is up about 20 percent since Jan.
2. Figures from the Office of the Comptroller of the Currency
show JP Morgan Chase having the largest exposure to gold
derivatives among U.S. banks and trusts as of Dec. 31.

JP Morgan Chase held $41.04 billion of gold derivatives of all
maturities as of Dec. 31, according to the Comptroller of the
Currency. The total amount of gold derivatives for U.S.
commercial banks and trusts last year was $63.3 billion.

McAvity sees the declining dollar and the move away from
Nasdaq and other expensive company shares as positives
for the gold price. The euro is zeroing in on 95 cents vs. the
dollar for the first time since January 2001. The dollar has
lost about 7 percent against the currencies of its major
trading partners thus far this year.

"The financial asset mania of 1982 to 2000 is now giving
way to a return to tangibles, and a precious metals trend
that should run for many years," McAvity says.

The gold fund manager most outspoken about the evils
of hedging, John Hathaway, sees fiscal distress for many
parties as gold prices rally. Hathaway's Tocqueville Gold
Fund has gained 81 percent since Jan. 2, holding largely
unhedged mining companies such as Gold Fields Ltd.
and Harmony Mining, both from South Africa.

"There is a huge outcry against hedging among investors,"
says Hathaway. "Mine company managements have
received a loud message from the investment world to
cover their hedge books, and all but the most obtuse will
be doing so."

Hathaway sees gold mining companies issuing new
shares to buy physical gold that they use to ameliorate,
or cover their forward sales of bullion. "Durban Deep was
the first to do it, and I believe there will be other, bigger
players," he said. Durban is a South African company
whose shares have gained 290 percent since Jan. 2.

Hathaway estimates that each $10 rise in the gold price
"means the collective bullion dealers have extended
another $1.4 billion to the gold mining industry, based on
a 4,000-tonne position."

Hathaway warns, "A $50 move, which is certainly in the
cards, would be $7 billion. What does this mean? It
means a serious squeeze on the bullion dealers, not the
mining companies for the most part. Central bankers who
have lent the gold to JP Morgan, Morgan Stanley, Goldman
Sachs, and others would not be happy with this situation."

What can the bullion dealers do about it? "Not a whole
lot, other than buying gold to cover their short, which is what
they are starting to do," says Hathaway from his Tocqueville
offices in New York City. "Most mining companies, especially
the big ones, have margin-free trading agreements with their
various dealers. This means they do not have to advance
cash when the gold price rises. It is too late for the bullion
dealers to go back to the mining companies to change the
deal, so they have no choice."

Hathaway sees Wall Street clean-up crews at work, frantic
in their efforts to erase the gold derivatives. "There are all
kinds of crazy, exotic deals made in the past that will come
to light -- exploding puts, knock-in calls, etc., which had high
fees originally but are now viewed as toxic waste by the
dealers who sold them."

The fund manager points out that actual gold supplies do
not move around as freely as those who need to cover
their hedging strategies would like. "Physical gold is illiquid
relative to short covering demand. This will take gold a lot
higher, unless the central banks step in, which I expect them
to do when the gold market gets really disorderly, like
gapping $10-$20 a day or more."


Thom Calandra is editor of CBS.MarketWatch.com.